Investment Theories*
EFFICIENT MARKET THEORY
• States that all known information about a security’s past, present, and future fundamentals is already factored into its price.
• And that the development of an unforeseen surprise surrounding the security, good or bad, cannot be profited from because the markets are quick to adjust to such information should it present itself. Moreover, the costs of carrying out such a transaction for a would-be profit seeker would reduce his return to nothing.
FIRM-FOUNDATION THEORY (FUNDAMENTAL SECURITES ANALYSIS)
“Go where the crowd just came from.”
• Growth and value oriented investors who carry out fundamental analysis on securities generally subscribe to this school of thought.
• Theory argues that each investment (stocks, real estate, bonds, etc…) has a “firm foundation” of something called intrinsic value.
• Intrinsic value can be determined by careful analysis of present conditions and future prospects.
• When the market price falls below (or rises above) this “firm foundation) of intrinsic value, a buying (or selling) opportunity arises, because this fluctuation will eventually be corrected as the markets are – as Buffett suggests – a frequently efficient mechanism which adjust to new issues surrounding a businesses very rapidly.
• Therefore, there are times when the markets tend to be inefficient. As markets are made up of investors, and investors are people, and people are prone to error (especially error of judgment).
• Thus, lucrative opportunities do present themselves from time to time.
• The business being invested in must carry strong past and future fundamentals (earnings growth and solvency) and have superior management.
CASTLE-IN-THE-AIR-THEORY (TECHNICAL SECURITIES ANALYSIS)
“Go where the crowd will be.”
• Chartist and day traders are generally linked as followers of this theory.
• The basis of this theory lies in the belief that “a thing is worth only what someone else will pay for it”. Therefore, sound valuation (of the security) is unnecessary as long as an unsuspecting “greater fool” is willing to pay more for it. The more suckers that fall prey to the baseless castle, the more the castle (stock) can rise (appreciate in price) with every pass.
• This theory, therefore, uses market psychology in timing the buy/sell decision rather than fundamental valuation.
• This is kin to a hypothetical beauty pageant in which the girl with the prettiest face and hottest figure is not necessarily chosen the winner, but rather the girl most admired collectively by the judges gets crowned.
*Burton G. Malkiel, "A Random Walk Down Wall Street"
• States that all known information about a security’s past, present, and future fundamentals is already factored into its price.
• And that the development of an unforeseen surprise surrounding the security, good or bad, cannot be profited from because the markets are quick to adjust to such information should it present itself. Moreover, the costs of carrying out such a transaction for a would-be profit seeker would reduce his return to nothing.
FIRM-FOUNDATION THEORY (FUNDAMENTAL SECURITES ANALYSIS)
“Go where the crowd just came from.”
• Growth and value oriented investors who carry out fundamental analysis on securities generally subscribe to this school of thought.
• Theory argues that each investment (stocks, real estate, bonds, etc…) has a “firm foundation” of something called intrinsic value.
• Intrinsic value can be determined by careful analysis of present conditions and future prospects.
• When the market price falls below (or rises above) this “firm foundation) of intrinsic value, a buying (or selling) opportunity arises, because this fluctuation will eventually be corrected as the markets are – as Buffett suggests – a frequently efficient mechanism which adjust to new issues surrounding a businesses very rapidly.
• Therefore, there are times when the markets tend to be inefficient. As markets are made up of investors, and investors are people, and people are prone to error (especially error of judgment).
• Thus, lucrative opportunities do present themselves from time to time.
• The business being invested in must carry strong past and future fundamentals (earnings growth and solvency) and have superior management.
CASTLE-IN-THE-AIR-THEORY (TECHNICAL SECURITIES ANALYSIS)
“Go where the crowd will be.”
• Chartist and day traders are generally linked as followers of this theory.
• The basis of this theory lies in the belief that “a thing is worth only what someone else will pay for it”. Therefore, sound valuation (of the security) is unnecessary as long as an unsuspecting “greater fool” is willing to pay more for it. The more suckers that fall prey to the baseless castle, the more the castle (stock) can rise (appreciate in price) with every pass.
• This theory, therefore, uses market psychology in timing the buy/sell decision rather than fundamental valuation.
• This is kin to a hypothetical beauty pageant in which the girl with the prettiest face and hottest figure is not necessarily chosen the winner, but rather the girl most admired collectively by the judges gets crowned.
*Burton G. Malkiel, "A Random Walk Down Wall Street"
posted by Raphael Blogger at
10:50 PM
